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Trade theories

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Trade Theories

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Trade theories

  1. 1. PRESENTED BY Aditya Suresh – 186 Akash Gupta – 188 Alankar Das - 190 Trade Theory-Global Business Management 2
  2. 2. CONTENTS 1.Mercantilism theory 2.Absolute Advantage theory 3.Comparative Advantage theory 4.Factor Endowment theory 5.Product Life Cycle theory 6.Leontief Paradox 7.Heckscher Ohlin theory 8. Porter`s Diamond theory 9.New Trade Theory Trade Theory-Global Business Management 3
  3. 3. WHY DO COUNTRIES TRADE ? 1. Availability of products (natural resources, new products, etc.) 2. International price differential as a consequence of:  Productivity differential  Differences in technology  Differences in factor endowments Economies of scale 3. Product differentiation and market structure Trade Theory-Global Business Management 4
  4. 4. WHAT IS TRADE THEORY Exchange of raw materials and manufactured goods (and services) across national borders Trade Theory-Global Business Management 5
  5. 5. MERCANTILISM THEORY The theory that a country’s power depended mainly on its wealth to build strong navies and purchase vital trade goods Trade Theory-Global Business Management 6
  6. 6. MERCANTILISM THEORY  In 17th century group of men (merchants, bankers, government officials & philosophers) wrote essays on international trade that advocated an economic philosophy known as Mercantilism In their view, a country becomes rich if it exports more than it imports Surplus in trade balance will result in an inflow of precious metals; gold and silver More precious metals means a richer and more powerful nation Countries have to do their best to increase exports and restrict imports. Trade Theory-Global Business Management 7
  7. 7. CONTD.. Since all countries cannot have surplus at the same time & because stock of metals is fixed in short run, a country gains from trade only at expense of others Wealth of nations was measured by stock of metals they possess  In contrast, today we measure wealth of a nation by its stock of human, man-made & natural resources available for producing goods & services Mercantilists advocated strict government control of economic activity because gain from trade comes at expense of other nations (i.e. zero-sum-game) Trade Theory-Global Business Management 8
  8. 8. CONTD.. GOLD AND SILVER ARE CURRENCY FOR TRADE THEORY SAYS YOU SHOULD HAVE A SURPLUS MAXIMIZE EXPORT THROUGH SUBSIDIES MINIMIZE IMPORTS THROUGH TARIFFS AND QUOTAS Trade Theory-Global Business Management 9
  9. 9. ASSUMPTIONS THERE IS A FINITE AMOUNT OF WEALTH IN THE WORLD A NATION CAN ONLY GROW RICH AT THE EXPENSE OF OTHER NATIONS A NATION SHOULD TRY TO ACHIEVE & MAINTAIN A FAVOURABLE TRADE BALANCE ( EXPORTING MORE THAN ITS IMPORT) Trade Theory-Global Business Management 10
  10. 10. LIMITATIONS In modern economy a nation holding gold will lose the competitive price advantage Mercantilism is expensive to implement because it requires complex navigation laws that are difficult to enforce Overlooked other sources of country’s wealth like capital & skilled work force Economic regulation tends to result in illegal activity or smuggling Trade Theory-Global Business Management 11
  11. 11. ABSOLUTE ADVANTAGE THEORY Adam Smith: Wealth of Nations (1776) argued: Capability of one country to produce more of a product with the same amount of input than another country A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient Trade between countries is, therefore, beneficial Assumes there is an absolute balance among nations Trade Theory-Global Business Management 12
  12. 12. CONTD.. Destroys the mercantilist idea since there are gains to be had by both countries party to an exchange Questions the objective of national governments to acquire wealth through restrictive trade policies Efficient production of goods leads to potential well being of people Both exporting & the importing country gain by engaging in trade Trade Theory-Global Business Management 13
  13. 13. LIMITATIONS Fails to explain how free trade can be advantageous to two countries when one country can produce all goods Country not having absolute advantage can’t gain from free trade Differences in climatic conditions & natural resources won’t lead to absolute advantage What if the country is bad at making everything? Trade Theory-Global Business Management 14
  14. 14. COMPARATIVE ADVANTAGE THEORY David Ricardo: (1817) argued: A country should produce only goods where it is most efficient & import those goods in which it’s less efficient Even if a country is efficient in producing all the goods, still trade between two countries will prove beneficial Assumes that a country does not have to be best at anything to gain from trade Country gains in those activities which it can produce at world prices even though it may not have absolute advantage Trade Theory-Global Business Management 15
  15. 15. LIMITATIONS • Ricardo's Theory was based on only two countries & only two commodities, but international trade is among many countries with many commodities • Assumption of full employment helps theory to explain trade on the basis of comparative advantage. Cost of production, even in terms of labour, may change as countries, at different levels of employment move towards full employment • Another serious defect is that transportation costs are not considered in determining comparative cost differences • Ricardian theory is not applicable to developing countries as these countries are nowhere near to full employment Trade Theory-Global Business Management 16
  16. 16. FACTOR ENDOWMENT THEORY  Trade theory holding that countries produce & export those goods that require resources (factors) that are abundant (and thus cheapest) & import those goods that require resources that are in short supply  Example:  Australia – lot of land and a small population (relative to its size)  So what should it export and import? Trade Theory-Global Business Management 17
  17. 17. CONTD.. 1.Assumes that production function are identical for all countries 2.Assumes that there is no unemployment Trade Theory-Global Business Management 18
  18. 18. 4-19 TWO FACTORS OF PRODUCTION •Labour •Capital
  19. 19. LIMITATIONS Assumes that the production functional are identical for all the countries Assumes that there is no unemployment Had poor predictive power Considered capital as homogeneous Trade Theory-Global Business Management 20
  20. 20. 4-21 •Trade theory holding that a country will begin by exporting its product & later undertake foreign direct investment as product moves through its lifecycle •As products mature, both location of sales optimal production changes •Affects direction & flow of imports & exports •Globalization & integration of economy makes this theory less valid PRODUCT LIFE CYCLE THEORY ( R .VERON ( 1966)) Trade Theory-Global Business Management
  21. 21. 4-22 Trade Theory-Global Business Management
  22. 22. 4-23 •Increased emphasis on technology’s impact on product cost •Explained international investment •Limitations •Most appropriate for technology-based products •Some products not easily characterized by stages of maturity •Most relevant to products produced through mass production PRODUCT CYCLE AND TRADE IMPLICATION Trade Theory-Global Business Management
  23. 23. HECKSCHER OHLIN THEORY  Given by Filip Heckscher  Explained link between factor endowments & comparative advantage of nations  Country has comparative advantage in those factors which make use of abundant factor  Free trade equalizes factor prices  Trade gains are greatest between countries with greatest difference in economic structure Eli Filip Heckscher (1879-1952) Trade Theory-Global Business Management 24
  24. 24. LIMITATIONS 1.Based on over simplified assumptions & is unrealistic 2.Gives undue importance to supply & less importance to demand Trade Theory-Global Business Management 25
  25. 25. LEONTIEF PARADOX  Given by Wassily Leontief in 1973  Found out that U.S. exports were apparently labour intensive & imports capital intensive  Findings were contradictory to predictions of Heckscher-Ohlin theorem  Stimulated enormous amount of empirical & theoretical research on subject Trade Theory-Global Business Management 26
  26. 26. LIMITATIONS 1.Leontief considered only capital & labour inputs, leaving out natural resource inputs 2.But in reality capital & natural resources are used together in production Trade Theory-Global Business Management 27
  27. 27. PORTER’S DIAMOND MODEL  Developed by Michael Porter in his book ‘The Competitive Advantage of Nations’  Explains why particular industries become competitive in particular locations  Competitiveness of one company is related to the performance of other companies  Demand, factor conditions, government policies help companies create competitive advantageTrade Theory-Global Business Management 28
  28. 28. LIMITATIONS 1.In his book, Porter was optimistic about future of Korea & less optimistic about future of Singapore 2.It was basically a home based concept & ignored the nature of multinational activities Trade Theory-Global Business Management 29
  29. 29. NEW TRADE THEORY  Collection of economic models in International trade which focuses on role of increasing returns to scale  This theory relaxed the assumption of constant returns to scale  Emphasized firm level differences in same industry of the same country  Also emphasized the growing trend of intermediate goods  Assumed that all firms are symmetrical, meaning they have the same production co-efficient Trade Theory-Global Business Management 30
  30. 30. Trade Theory-Global Business Management 31
  31. 31. LIMITATIONS 1.Can only treat a situation when there are many firms with different production processes 2.Assumes that all firms are symmetrical, which may not be true in every case Trade Theory-Global Business Management 32
  32. 32. Trade Theory-Global Business Management 33

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